The Psychology of Trading Without the Ego

BY BRETT STEENBARGER, PH.D.


A surprising amount of poor trading comes from trading our egos, not from actually trading markets.

When we focus on predicting market moves and trading our views with conviction, trading rapidly becomes a game of the ego.

When we declare that we have a certain trading “style” and we wait for market conditions to accommodate our style, trading becomes ego-based.

When we obsessively watch screens and focus on each move of P/L, trading turns into an ego game.

We can use every technique under the sun to instill discipline and overcome emotions, but if we pursue trading through the ego, we will be vulnerable.

An analogy I’ve used in my books is the good dancer on a dance floor.  The good dancer doesn’t just dance his or her style regardless of the music playing.  The good dancer does not start dancing ahead of the music, anticipating the next tune.  The good dancer waits for the music to start, catches the beat and tone, and dances accordingly.

In my recent trading, I've been taking ego out of the picture. I examine a stable lookback period in the recent market and identify two things:
  • Has there been a dominant trend over that period?
  • Have there been one or more dominant cycles over that period?

If I can detect no clear trend or cycles, I don't trade.

If there is no trend, but a dominant cycle, I trade the hypothesis that this cycle will continue into the immediate future unless I see clear changes in market volume, volatility, news events, etc.  That has me buying prospective cycle lows and selling highs.  In that regime, I look like a value trader.

If there is a distinct trend, but no clear cycle, I use the first pullbacks/bounces in the NYSE TICK to enter and ride the trend, again unless I see clear evidence of changes in the market’s trading.  In that regime, I look like a momentum investor.

If there is a distinct trend *and* one or more dominant cycles, then I am using the cycles to guide entries and exits in the direction of the trend.  In that regime, my execution is counter-trend (value), but the overall idea is trend-based (momentum).

We suffer when we expect markets to trade the way *we* want them to trade.  There are valuable tools that help us identify cycles and trends.  That enables us to enjoy the market’s dance music–and profit from it.

Original Article